Asymmetric information in insurance markets: Predictions and tests

Abstract

This chapter surveys a number of recent empirical studies that test for or evaluate the importance of asymmetric information in insurance relationships. Our focus throughout is on the methodology rather than on the empirical results. We first discuss the main conclusions reached by insurance theory in both a static and a dynamic framework for exclusive as well as nonexclusive insurance. We put particular emphasis on the testable consequences that can be derived from very general models of exclusive insurance. We show that these models generate an inequality that, in simple settings, boils down to a positive correlation of risk and coverage conditional on all public information. We then discuss how one can disentangle moral hazard and adverse selection and the additional tests that can be run using dynamic data.